South Korea May Jump on Rate Cutting Bandwagon

After three central banks moved to cut rates recently, expectations are growing that Asia's fourth largest economy - South Korea - could follow in their footsteps on Thursday with a surprise rate cut.

On Tuesday the Reserve Bank of Australia (RBA) surprised investors by cutting rates by 25 basis points to 2.75 percent, while last week the European Central Bank cut rates by the same amount to a record low of 0.5 percent. The Reserve Bank of India also lowered rates for the third time this year last Friday.

Now some analysts are saying the Bank of Korea (BOK), which has not cut rates in its last six meetings, could follow suit, although the broad consensus is for rates to remain unchanged.

"Given that the RBA and central banks around the world have been cutting rates, it won't be surprising if the Bank of Korea decided to jump onto the bandwagon," said Kelly Teoh, market strategist at derivatives trading firm IG.

In its April meeting South Korea's rate-setting committee held the policy rate steady at 2.75 percent in defiance of both market expectations and the government's pressure for a cut. It last cut rates in December. However, more recently calls for a rate cut in May have risen, following a series of disappointing data from the country.

Industrial production fell 3 percent year on year in March, following a 9.4 percent contraction in February, for example. Meanwhile, South Korea's consumer inflation unexpectedly eased in April to 1.2 percent from 1.3 percent in the previous month, well below the government's target of between 2.5 percent and 3.5 percent for 2013-2015. All these factors could help contribute to a more dovish tone at the Bank of Korea, said analysts.

"ING is forecasting a 25 basis point cut to 2.5 percent [at Thursday's meeting]," said Tim Condon, head of research for Asia at ING Commercial Banking. He added that disappointing data might have unnerved some Korean central bankers.

"We switched our vote on the release of the minutes of the April Monetary Policy Committee [MPC] meeting, which told us that the positions of the MPC members were not set in stone. We think the data released since the April meeting, notably March industrial production and CPI data... would cause at least one more member to vote for a cut," he added.

The South Korean economy is also facing global headwinds, which could put further pressure on the BOK to cut rates, namely the rapid depreciation in Japan's currency, which has made South Korean exports less competitive, in addition to sluggish demand for its products.

IG's Teoh said the weakening yen would prove a key driver for a rate cut: "The Bank of Korea is under pressure to cut rates as they are losing competitiveness with the weakening yen."

Positive Indicators

However, there have been some positive developments for the economy this year. South Korea's first quarter gross domestic product (GDP) growth at 0.9 percent quarter on quarter, was its fastest pace in two years.

Furthermore, this week South Korea's parliament approved the government's 5.3 trillion won ($4.84 billion) additional fiscal spending plans, which along with other stimulus measures is expected to lift economic growth by a few percentage points.

These more positive indicators have meant the majority view from analysts is that rates will remain unchanged on Thursday. A Reuters poll published on Wednesday showed that 16 out of 26 analysts surveyed anticipated rates would remain unchanged.

The Bank of Korea forecast in April that the economy would grow 2.6 percent in 2013, below its January projection of 2.8 percent.